Arbitrage managers look to generate positives out of negatives
A group of small but ambitious French merger arbitrage managers bucked the trend for negative performance in 2011 and are planning a repeat performance for 2012.
Event-driven hedge funds frustrated investors in 2011 with negative performance across the board – the HFRX M&A index finished the year down 2% and the HFRX Event-Driven index down 5%.
Part of the problem is the variety of strategies within the event-driven arena. Morten Spenner, CEO of fund of hedge funds International Asset Management (IAM), describes the event-driven space as a “silly bucket which can include merger arbitrage, distressed debt and special credit – these strategies have little in common with each other”.
Spenner has been put off the M&A strategy due to the “limited number of managers who are very good at consistently taking limited risk with decent transactions. Everyone expected M&A to be more prominent than it has been”. Consquently, he reduced IAM’s allocation to M&A.
But a number of niche hedge funds are out to prove him wrong. French hedge fund CIAM Merger Arbitrage launched in September 2010. Anne-Sophie d’Andlau, one of its three founding partners, says the following year was “challenging but interesting”.
The key challenge for CIAM was staying within the fund’s risk metrics while taking advantage of market volatility last summer. D’Andlau explains: “The spreads widened on most of our positions, so we needed to add to them while making sure the deals were still on. For a young firm like ours, we were able to learn how to bring together our portfolio and risk management.”
One of the trickier deals d’Andlau refers to involved Canadian mining company Lundin Mining. During the bidding process, CIAM took the traditional M&A route of going long on the target company, a strategy that seemed safe as Lundin had received cash offers. But when the deal went wrong, the fund was not covered. CIAM has since decided to cover counter-offers and hostile situations when it anticipates higher offers. This is achieved via put options, which limit the downside.
D’Andlau says: “We improved our risk management process. Even when you are experienced, you can always improve.”
Her fund ended 2011 with a slight negative performance. She believes the fund did “relatively well given the environment” as her team “handled [challenges well] and proactively informed investors”.
Throughout the past year, the fund attracted a lot of media attention, in part due to the originality of its management team: CIAM’s three founding partners are all women.
Yet its near-flat performance in testing markets did not go unnoticed by investors. In 2011, the fund saw €30m of inflows, primarily from Dutch seeder IMQubator.